Analyst: High oil prices reverse gas, oil price decoupling

High crude prices have reversed the 'decoupling' of oil and natural gas markets that almost everyone in the energy industry has taken for granted in recent years, say analysts at ICF Consulting Group.

Jul 12th, 2000

Sam Fletcher
OGJ Online

High crude prices have reversed the "decoupling" of oil and natural gas markets that almost everyone in the energy industry has taken for granted in recent years, say analysts at ICF Consulting Group.

Although US demand for gas is growing, high oil prices "are, by far, the primary driver" behind the recent spike in natural gas prices above $4/Mcf, said Michael L. Godec, senior vice-president and managing director of ICF Consulting's oil and gas practice.

"Today's conventional wisdom holds that crude oil prices no longer have significant influence on natural gas prices. But this decoupling appears to have been reversed, at least for the time being," he said.

Through much of its history, natural gas has been overshadowed by oil, almost never drawing a comparable price based on btu content. Customers with dual fuel capacity were always ready to switch back to fuel oil if gas prices climbed too high or supplies fell too low.

However, other energy experts claim that changed some years ago as the North American gas came into its own, with construction of new gas-fired electric power plants. They say rising demand for gas finally decoupled rising gas prices from falling oil prices in a world then awash with crude.

ICF's contrarian view
For some years now, North American drilling activity has been heavily weighted toward natural gas as oil markets largely languished. But the industry's perception of decoupled oil and gas prices is "either a myth, or else it only decouples when oil prices are low," said Godec.

An ICF analysis of the gas market over the last 2 years, which his group is now "fine-tuning," shows that "oil and gas prices decouple when excess gas supply exists and oil prices are low," Godec said. "But today, the situation is the opposite; oil prices are high and gas supplies are tight. As a result, oil and gas prices at the burner tip are near parity and have again become coupled."

Certainly, low oil prices in 1998 and early 1999 reduced producers' cash flow and dampened drilling for both oil and gas, tightening gas supplies and helping drive up gas prices.

Tight supplies appear to be sustaining higher gas prices in the short-term, said Godec. But he and other ICF officials claim gas deliverability concerns are short-term phenomena, since new gas reserves will be added as drilling picks up. "We're bullish on the potential of North American basins to deliver gas," Godec said.

And as gas supplies grow, he said, "High gas prices are not sustainable."

However, others in the industry say current gas reserves are being depleted faster than they can be replaced through new drilling. They claim that the strain of maintaining current production levels plus adding even more reserves to satisfy a rapid increase in demand is certain to keep gas markets tight regardless of what happens with oil prices.

Analysts at Simmons & Co. International said Tuesday they see growing markets for both world oil and North American gas over the next 12-18 months. Although drilling activity will increase, they predict no significant dampening effect from new oil or gas production during that time.

Godec says even industry experts have consistently underestimated recoverable petroleum resources in the past. Technology plays a crucial role in reducing finding and lifting costs to bring new reserves into production, he said.

The only "wild cards" to worry about, said Godec, are the funding of research and development of future technology and new environmental restrictions on exploration for oil and gas.

The timing for a decline in gas prices is uncertain, Godec said, depending on how long oil prices remain high. If high oil prices are sustained, he said, then gas prices also will remain high for the short term, declining slowly as sustained drilling increases gas deliverability.

But if oil prices drop, he said, gas prices will remain coupled and will follow oil prices down until they "reequilibrate" at a lower level at parity with petroleum product prices.

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